Group Investment Insights
A survey of CCIMs reveals the latest trends in syndication management.
Commercial real estate professionals are pooling their real estate knowledge and skills with investors’ financial resources to act on the current market’s buying opportunities. Often referred to as “sponsors” rather than syndicators, they hope to create attractive group investment packages.
Combining the resources of several investors and a sponsor produces numerous benefits for commercial real estate professionals. Investment groups may be able to acquire bigger properties than individuals alone and obtain financing more easily with a larger down payment. One investor’s credit problems may be offset by the addition of several more-creditworthy investors. Investors with substantial financial resources who lack deal-making expertise can rely on an experienced sponsor to facilitate the transaction.
While many commercial real estate professionals are capable of brokering transactions or even owning their own properties, it takes a person with unique skills to properly manage an investor group through a long-term commitment to a successful project. The sponsor’s value to the investors may rest with management skills as well as transaction capabilities.
Since 1996, the CCIM Institute has asked members repeatedly about their involvement with group investments, with subsequent surveys conducted in 1999, 2001, 2003, and 2008. The results of the survey completed earlier this year show how trends in this part of the commercial real estate industry are changing.
The current survey was conducted only among institute members, with 433 designees and candidates completing the survey. In 2003, the survey included both CCIM and Institute of Real Estate Management members and the total number of respondents was 312. Survey methodology allows the responses from only CCIM members to be considered in the comparisons. The increase in responses from CCIM members indicates a growing interest in group investing today.
Group Financial Trends
The most dramatic change reported this year is that the total amount of money expected to be raised in each group has doubled since 2003, from a median of $500,000 to a median of $1 million. Additionally, while only 25 percent of the groups in 2003 expected to raise more than $1 million, more than 39 percent of the groups in 2008 are expecting to raise more than $1 million.
Even with the increase in the amount of money each group expects to raise, the long-term trend continues toward fewer investors in each group. In 2008, 85 percent of all groups are expected to have less than 10 investors compared to 1996, when 75 percent of the groups had 10 or fewer investors. In the last two surveys, the most frequently chosen group size is between three and six investors.
While the amount of money expected to be raised has doubled and the size of the groups continues to decrease, the amount each investor is expected to contribute is rising. In 2008, 64 percent of respondents expected the minimum investment from a single investor to be greater than $50,000 with the median being $100,000. In 2003 the median was $75,000, which had increased from $50,000 in the first survey.
Real estate markets are cyclical, and the product type that investors favor changes with the cycles. Retail, multifamily, office, and land are the highest-ranked property types in the current survey, with car washes and laundromats the most unusual choices. In 2003, retail and office were almost equal in popularity but office properties appear to have lost some appeal in the current survey.
Common Group Structures
Limited liability companies remain the entity choice of most group sponsors as they have since 1996. In this year’s survey almost 79 percent of sponsors indicate they use an LLC while almost 17 percent use a limited partnership. While the LLC is the most common entity, the use of an LP is sometimes dictated by states that require gross receipts tax on LLC revenues but not on LP revenues. Use of an LP also protects large investors from having a fiduciary duty to smaller investors, in that a limited partner cannot have any management responsibilities, but a member in an LLC may make decisions that will affect the investment’s outcome for the other members. In addition some sponsors think that LPs give them greater control over large groups of investors.
In 2008, 20 percent of respondents said they were using the tenancy-in-common structure to form investment groups. While not an entity, the TIC structure is popular when individual investors desire the tax deferral offered by an Internal Revenue Code Section 1031 exchange as an entrance or exit strategy. However, many sponsors find that it is very difficult to collect distributions and fees from TIC structures and continue to use LLCs as their entity choice for group investments. These sponsors generally do not concern themselves with investors who desire tax deferral as an acquisition or disposition strategy.
Sponsors continue to struggle with the concept that their organizational structure may be considered a security and that they must act in accordance with laws of the Securities and Exchange Commission. Sponsors can comply with securities laws by ensuring that their offerings are exempt from registration by keeping them within the established guidelines. Sponsors must obtain competent legal counsel to draft their documents.
The amount of organizational fees paid by sponsors remains stable, between 1.5 percent and 4.0 percent of the equity raised from investors. Small offerings usually have organizational fees in the 3.0 percent to 4.0 percent range, as legal, accounting, printing, and underwriting fees are relatively fixed costs that do not vary with the amount of equity raised.
After several years of a downward trend in sponsor compensation, the 2008 survey shows that sponsors are expecting to receive approximately 20 percent of the profits, cash flow, or ownership interests from their group investments. The figure was 25 percent in 1996, decreased to 17 percent in 2001, and rose to 18 percent in 2003.
Experienced sponsors have found that brokerage, leasing, property management, and financing fees are paid on every property, whether it is owned by a group or not. Sponsors should not count those fees as profits coming from managing groups. In fact, sponsors should get paid for managing groups regardless of who conducts the traditional real estate brokerage activities.
Financial modeling software can help sponsors to determine a present value of the fees they expect to be paid for managing groups based on an appropriate discount rate that reflects the risk they are undertaking. If the present value is not adequate for the risk, the sponsor should not proceed with the group investment.
In every survey, respondents were asked to list the mistakes they have made in past syndications. This year, as in the past, sponsors identified two major areas as trouble spots and added one new area.
Member Management. Comments such as “Did not screen partners carefully,” “Picked the wrong partners or investors,” “Did not include certain partners or investors,” “Included too many partners or investors,” and “Did not make sure there was no conflict of interest among investors” reflect a recurring theme from past surveys. The group investing business is as much about managing the investors as it is about managing the property. This realization surprises many commercial real estate professionals who decide to enter into this business.
Ideally, sponsors should have an established pre-existing business relationship with each group investor. If all sponsors adhered to this principle, they would know their investors well enough before the group is formed, minimizing the opportunity for problems. However, sometimes problems surface between members and, inevitably, the sponsor must act as a referee.
While having a strong relationship with each investor is one way to solve this problem, sponsors struggling to raise money often are less choosy when they want to complete the group’s funding. Another way sponsors deal with member management is by limiting the number of investors they take into each new group. However, this requires finding investors who can invest larger amounts in the group.
Risk/Reward Imbalance. A common response from sponsors is that the fees they received as a result of their group investments were not sufficient to offset the risk they felt they had taken. Comments such as “Did not pay myself enough,” “Did not receive a sufficient fee for all my work,” and “Did not fully realize the amount of time and effort necessary” relate to the balancing of risks and rewards in the group investment process. In 1996 the sponsors stated that they were asking for 25 percent of the profits and for several years this percentage dropped to 17 percent. In this year’s survey, sponsors are asking for an increase equal to 20 percent of the profits.
Some of this regret may be self-imposed if the sponsors do not set up the investment structure to generate enough fees. For example, if sponsors are not comfortable with their ability to raise money, they may set their fees very low to help attract investors. Some sponsors actually do not ask for any fees and only collect traditional real estate brokerage fees from the group, in effect, managing the group for free. Others simply may be doing their first group investment and underestimate the amount of work required and the risk they are going to shoulder.
Sponsors first should determine what fees or distributions they need to make it worthwhile to take on the responsibility of running the group. A present-value approach to those fees, at a discount rate that is adequate compensation for the risk involved, allows the sponsor to evaluate future compensation in today’s dollars. Once the sponsor is satisfied with the fee or distribution arrangement, he or she should then evaluate whether there is enough return left to entice investors to enter the transaction. If not, instead of lowering the fees or distribution to make the deal acceptable to the investors, the sponsor should not proceed with the transaction.
Structure Problems. For the first time, respondents expressed concerns about their group investment structure. Comments such as “Did not put everything in writing/should have improved legal documents,” “Did not explain the concepts or risks to investors thoroughly,” “Did not communicate clearly with investors,” “Did not develop exit strategies in documents for those who want to get out,” and “Wrong legal structure,” indicate a lack of experience on the part of sponsors and the associates they assemble to put together the group. Many sponsors do not realize that structured documents should be drawn up by an attorney with group investment experience and reviewed by a certified public accountant with real estate experience. Aside from the fact that most groups are structured as securities and require specific documents, sponsors do a disservice to their clients when their documents are poorly drawn or non-existent.
Before sponsoring investment groups, commercial real estate professionals should review the results of this survey for ideas and areas that others have found problematic. Strong real estate fundamentals are important, but the ability to manage the investors in the group may be equally important.
Number of Investors in a Group
|Less than 5
|5 to 10
|11 or more
Amount of Capital Raised for Each Group
|Less than $1 million
|$1 million to $5 million
|More than $5 million
Minimum Investment for Each Investor
|$25,000 or less
|$25,001 to $50,000
|More than $50,000